There are loads of different ways to get behind the steering wheel of a decent car, even if you don’t have the current cash to buy one outright. One of these is called personal contract purchase (also known as ‘PCP’).
It’s a type of car finance option that you can use to lease a car for relatively low monthly payments. Unlike car leasing (contract hire), PCP gives you the opportunity to buy the car at the end of your contract by paying what's called the balloon payment.
Here’s some more information about what personal contract purchase is all about, how it works, and the main advantages and disadvantages of it.
What is Personal Contract Purchase?
With a PCP agreement, you’ll agree to mileage restrictions and to return the car in a particular condition at the end of the contract. You’ll then pay fixed, monthly installments, over a period of time – usually between two and five years. As the registered keeper of the car, you’ll be responsible for its maintenance, MOT and repairs – but you won’t actually be the legal owner.
At the end of the agreement, you’ll be given three options.
The first is the chance to get full ownership of the car by paying a final fee, called a balloon payment. This amount is based on what your finance company expects your car to be worth when you’ve finished paying the installments and it’s usually pretty hefty.
You’ll also have two other choices: you can either return the car to the finance company and walk into the sunset; or you can part-exchange it, using any leftover value in your agreement to go towards your deposit for a new personal contract purchase agreement on a new car.
The last option is probably the most popular when it comes to this type of finance – the fact that you can put any extra money towards the deposit for a new car is a major draw for a lot of people – particularly with those who change their cars as often as they change their socks.
Sounds great, doesn’t it? There are some things to consider though.
It’s worth bearing in mind that you’ll only be repaying part of the car’s overall cost in your monthly repayments – the difference between the value of the car at the start of the agreement and the predicted, residual value of it at the end. Simply put, this that means you’re paying off the value that the finance company expects the car to lose whilst you’re in the plan– not the full value of the car.
This has positives and negatives. Your fixed monthly payments will be lower because you’re not paying off the full value of the car. But, for the same reason, this means you’ll also be left with a bigger final payment – the aptly named, ‘balloon payment’ – if you want to become the legal owner of the car.
The low monthly payments, low interest and inherent flexibility of PCP make it a popular type of finance with people who change their cars regularly. If you get bored with the same old car after a few years, this is probably the right type of agreement for you.
New vehicles are the most popular type of PCP car but you can also find used PCP cars too, if you look hard enough.
For the people who live, sleep and breathe legal technicalities, personal contract purchase is what’s known as a conditional sale agreement and, under UK law, people who take part in it are protected by the Consumer Credit Act 1974 and the Financial Services Regulations 2004.
What is a balloon payment and how is it calculated?
The balloon payment is the final fee that you pay, if you want to become the legal owner of the car. It will often be quite high because – obviously – your monthly payments aren’t covering the full value of the car.
Balloon payments are calculated at the start of your agreement by working out a figure called the Guaranteed Minimum Future Value of the car. The GMFV is calculated by looking at the residual value of the car – or what it’s expected to be worth when you come to the end of your agreement – as well as trade guidelines, and a number of other factors, like your estimated mileage and the type of car you’re leasing.
Most finance companies offering PCP will put mileage restrictions and condition specifications into the agreement too. This means that in order to return the car without financial penalties, you’ll have to make sure it hasn’t exceed a specific mileage and is in a specific condition when you return. If you do go over your mileage allowance, expect to pay a certain amount – usually 1p to 5p – for every mile extra you travel.
How does Personal Contract Purchase work?
Here’s the nitty gritty of how it works.
First things first, you need to find a car and a finance company who offer PCP and are willing to offer you an agreement.
Once you’ve done that, your balloon payment will be calculated, you’ll put down an initial deposit and agree fixed monthly installments for specific period of time.
There’s a good rule to bear in mind for this. Generally, the higher your deposit, the lower your monthly payments will be, but this depends on how high your APR is (which can often vary a lot between different finance companies). Bizarrely, a low (or non-existent) interest rate can make an agreement with a deposit work out near enough the same in cost, over the long term, as an agreement without a deposit, so make sure you check the small print before committing to anything.
After this, your balloon payment will be calculated and you’ll also agree to particular mileage restrictions and conditions. You’re then all set to pay those fixed, monthly payments with interest and VAT for the duration of the agreement – usually around two to four years.
When all that time’s passed, you’ll be offered the chance to pay the balloon payment and become the legal owner of the car, the option to walk away and the option to part-exchange your current car for a new one on another PCP agreement.
Sometimes, your car can be worth more than the predicted GMFV when you come to the end of your plan and this means that you’ll have leftover money. You can’t withdraw this as cash, but you can put it towards the deposit for a new personal contract purchase agreement for a new car – a key attraction of this type of finance for a lot of people. And one that can let you get yours hands on a high-value car that you might not be able to afford otherwise.
What are the advantages of Personal Contract Purchase?
There are obviously a lot of different finance arrangements for getting hold of a car out there, so why would you choose personal contract purchase over others, like hire purchase or personal contract hire?
Here are some of the main advantages of PCP:
- You can often get pretty high quality, high value-cars for a low monthly cost
- Payment for the car is spread out over a period of time, minimising the immediate damage to your bank account
- It’s a particularly popular type of finance which means you’ll have lots of choice when it comes to finance companies and agreements
- You’ll have several options to choose from at the end of the agreement, from becoming the legal owner of the car through to returning the car or part-exchanging it for another one
What are the disadvantages of Personal Contract Purchase?
We’d be lying if we said that personal contract purchase agreements were perfect – they obviously won’t be right for some people. Here are some of the main disadvantages that people can come up against with PCP agreements:
- The final balloon payment can be particularly large, so if you want to become the legal owner of the car at the end of the instalment plan, be prepared to stump up a lot of cash from somewhere
- You’ll have to stick to strict mileage limits: expect to be charged for each mile that you go over
- You won’t be able to sell the car without the permission of the finance company as you don’t technically own it
- You’ll need to return the car in the condition that you agreed at the start of the agreement–– not great if you work your vehicles pretty hard